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Composition of Board of Directors

When a company is formed, the initial board of directors will be appointed. Often, a start-up company's initial board of directors is composed of its founders. For start-ups, board meetings are typically informal, if held at all. When a board meeting is held, a written record (minutes) should be kept to document the occurrence of the meeting and any specific actions authorized (corporate resolutions), and to summarize the matters discussed. New companies should not make the mistake of failing to keep complete and accurate books and records. When it comes time to raise capital or sell or merge the company, potential investors will review the corporate records during their due diligence. Sloppy or missing records could jeopardize the transaction. If challenged, directors may have a more difficult time proving that they fulfilled their fiduciary duties where the record of their meetings is incomplete.

Whereas the direction of the business may be the primary topic of the day-to-day discussions among the founders, formal board meetings would be held to approve the company's strategic objectives and any extraordinary corporate transactions. Many board actions are taken through a written consent signed by all of the directors, without actually having a meeting. As a company gets closer to its first round of venture capital financing, founders should seek out additional directors who will lend credibility and who may offer assistance in terms of industry or financial contacts. Locating outside directors is no easy task. With all the attention and additional scrutiny directed at corporate governance issues and director liability following Enron's collapse and other corporate scandals, the task is only getting harder. Further, with limited cash resources, no public market for a private company's securities, and uncertainty as to whether there ever will be a public market, start-ups have a challenging time attracting directors based on director compensation, most of which is typically stock options. Where do first-time entrepreneurs find these outside directors? Anywhere they can.

Once a company receives its first round of venture financing, both its board's composition and function will take on very different complexions. Whereas prior to the initial venture round, a company's board may have been comprised of the founders, senior corporate officers, a seed investor or two, and possibly an outside director with industry contacts, once the company reaches the venture stage, the composition of its board will likely be dictated by the new investors. Venture investors often take one or more board seats as a condition to their investment and work with the founders to find individuals with experience in the company's industry to serve as independent outside directors. The terms of the financing will spell out the company's new governance structure. Directors who served prior to the venture round but are not critical to the enterprise may be asked to resign at this stage. An important point to keep in mind is that each director has an equal duty to all shareholders, regardless of who employs the director or who nominates him or her to the board. A venture capital firm's nominees on the board may not look out for the interests of their own firm to the detriment of the other shareholders. This often is a difficult line to walk as conflicts may arise.

As noted above, when seeking an outside director, early stage companies tend to focus on someone who can help lend credibility to the company. Venture-backed companies are much more focused on directors who bring their industry expertise to bear in helping the company, both through board member experience and contacts. Newly public companies have concerns similar to those of venture financed companies, while more mature public companies tend to seek out capable directors from a wider range of backgrounds. In all cases, selecting individuals with the highest integrity should be a prerequisite. Companies should seek outside directors who understand their fiduciary role as a stockholder representative and advocate. Before looking for a new director, to better define a board's needs, current directors should ask themselves: (a) What is the board looking for in a new director? (b) How much involvement outside of regular meetings is expected? (c) What skills and contacts does the prospective director bring? (d) Are there limitations (time or otherwise) on the prospective director's ability to serve as a director? (e) What is the chemistry among the existing directors? How will it change with the addition of the prospective director?

The word “director” implies the active role of someone who directs. Serving on a corporate board should not be a passive activity. Tensions may exist between the chief executive officer and the outside directors. CEOs expect more engagement and active participation from their outside directors and want to know how to get more out of the directors. Although many of the outside directors on a venture funded company's board are investors or representatives of the investors, this tension still exists. When choosing directors or when considering an opportunity to join a corporate board, the prospective director and the current directors should strive for an understanding of each party's expectations. There should be frank and straightforward dialogue to clarify what the parties expect from each other. Setting a prospective director's expectations prior to joining the board will help facilitate the new director's transition onto the board and enhance board dynamics.